When should I sell a losing stock?

Today’s post is a short one. Lately, Mr. Market has been in quite the mood, and a lot of people (yours truly included) have seen the much dreaded red minus in front of their positions’ values. It begs the question: “Should I sell my position? Should I hold? Or should I even buy more?” To make that call, I have found a few lessons from some of the investing community’s greatest wizards.

The stock doesn’t care about you: Warren Buffett once stated something along the lines of: “A stock doesn’t know you own it. It doesn’t care about you.” The statement is so obvious, but it still touches upon a bias that most of us are prone to – even billionaire Edward Thorpe. In his book, A Man for All Markets, Ed remembers the beginning of his career where he based his sell decisions around the price he paid. Namely, he would not sell a ‘loser’ unless its price returned to his purchase price. He wrote: “My plan for getting out […] was to wait until I was even again. What I had done was focus on a price that was of unique historical significance to me, only me, namely, my purchase price.” I think we have all tried to anchor a decision around either a price, perception or hope. Yet, it would have made more sense to…

Take the loss if your investment thesis proves wrong: In Fooling Some of the People All of the Time, David Einhorn advises the reader to put one’s pride and stubbornness aside when one’s investment thesis is not realized. You should never try to justify the position, as captured in this quote: “[We] avoid “evolving hypotheses.” If our investment rationale proves false, we exit the position rather than create a new justification to hold.” (p. 17) Another great quote originates from psychologist Philip Tetlock: “Beliefs are hypotheses to be tested, not treasures to be guarded.” Hence, if the reasons you bought the stock are not as compelling as they once was, forget the price you paid and leave your stubbornness at home – sell! As I have learned the hard way, it’s much better to sell sooner than hoping to break-even someday. In The Most Important Thing Howard Marks explains that succesful investing is about constructing a portfolio that consists of the best investment ideas, which you make room for by selling the inferior ones and staying clear from the worst of the lot. To make that dogma come true, one needs to be willing to get rid of the inferior ones. I am not saying you should sell every time a stock moves into the red zone. Sometimes Mr. Market is wrong, and that’s where the big money can be made. As David Einhorn says in Fooling Some of the People All of the Time: “If you know you are right, all you need is patience, persistence, and discipline to stay the course.” (p. 42)

Forget the trade: Once you’ve sold – regardless of whether you made a profit or a loss – you should forget about the trade. Too many (including yours truly, once again) check stock prices on one’s sold positions – that is a surefire way to get frustrated if the stock appreciates afterwards. In Contrarian Investment Strategies you are advised to “realize profits, forget the stock, and start hunting for the next opportunity.” In length, remember Warren’s comforting words: “Don’t try to buy at the bottom and sell at the top. This can’t be done – except by liars.”

To sum up, the sell decision is incredibly hard to make. I can tell you with 100% confidence that I have yet to master the art. I hope, however, that I will be able to ‘eat my own cooking’ and follow some of the advice outlined above when I am once again facing the ungrateful decision on whether to buy more, hold or sell a losing position.

NB! Please note that this post didn’t cover the topic of when to sell a winning stock. Yet, I touched upon this topic in my last post, Warren Buffett’s Investment Strategy.